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Strategies & Market Trends : Mish's Global Economic Trend Analysis -- Ignore unavailable to you. Want to Upgrade?

To: zonder who wrote (14131)	10/27/2004 3:07:46 PM
From: mishedlo	Read Replies (1) \| Respond to of 116555

Plunger on Deflation I was looking at a chart of Real US yields (nominal less inflation) maybe calculated from TIPS and the like, and it averages 2-3%, is 2% right now ang got up to 6-7% in the Volcker inflation pogrom. Most people look at it and say real yields have probably bottomed. Especially as the USD has to fall, so who would want the bonds? But, we don't know the USD will fall, when or if. And after it's fallen, that move is history. But actually my main argument for lower still real yields is that globally there's too much propensity to save and too little propensity to consume. So, we get high asset prices, weak activity, low earnings and yields and sky high P/Es. The Fed hiking into this is anomalous because if you want to encourage people to spend you have to keep asset prices high so they feel good and you have to not give them any alternative to buying high asset prices or spending. The Fed is providing the alternative of holding cash. So they will cool asset prices and they will reduce consumption. Now of course in the big big picture this is the right policy. But for maintaining consumption and activity it is not, and for most asset prices it is not. It is weakening consumption and the bond market senses it. US savings rate is what 1-2% now down from a steady 10% up to the early 1990s. This has to rise as people consider those extra 10 years they will live compared to grandpa, and that they need to have some funding for them. Yet even now because so much is spent on goods from abroad, in order to just keep the US economy ticking over, the government needs to run a 5% of GDP deficit. Anyone who thinks that's outrageous, think how much more unemployment there would be without it. 5% more at least. Again in the big big picture cutting that might be the answer. But it is not happening and a short term or even a strong medium term politician couldn't do much because the pain would be just so bad. So the government deficit and the reason politicians can't vote against it is because the economy is soft. Look at Japan. Running an 8% of GDP deficit for a decade, and a zero interest rate policy for nearly as long. Just to keep the economy BARELY ticking over. All to offset the personal propensity to save for that hopefully very extended retirement. What can they do with the savings? Well because there's no need for more productive capacity in Japan because there's no incremental demand, investment opportunities are rather thin. because the population is not increasing, demand for property is not so buoyant. So they send their savings to the US. Not to buy trophy properties publicly and so be villified, just quietly into debt securities. What would you do otherwise in their shoes? And Europe, does anyone else notice that one by one every European government seems to be having trouble staying within the Maastricht 3% of GDP budget deficit limit? Why? Because they want to keep their economies ticking over and private demand isn't there. People want to save for their hoped for very extended retirement and the governments there need to supplement economic activity in the meantime. How about China. Well interestingly that is the one place that does have productive investment opportunities. So much so that they spend 45% of GDP on investment against an equilibrium level of 20% or so at their target 9% ish growth rate. It means they are growing capacity much faster than demand. Faster than world demand. At some point they will catch world demand, and their rate of investment will have to slow dramtically. Rather like Cisco's "wall" of Dec 2000 when customers just said they didn't need any more, and certainly not "more" more. But yes US demand could keep going. Until that is, the collateral against which to borrow runs out owing to lack of net equity remaining. This will happen at some point as US assets are finite. But the desire of Japanese and of Chinese factory oweners to be rich knows no bounds. Double their net worth? Treble? More please! So which is going to soften and run out first, the US ability to borrow and supply debt or the Asian desire to hold assets? And if demand exceeds supply, interest rates will fall as the price of bonds rises. And as the US consumer tries to consume a little less, since he has problems funding expenditures, activity weakens and the Fed will have to lean back into the deflationary wind. Not to mention the GOP "ownership society" whereupon US holdings of assets are sharply split bewteen the owners, who act and think pretty much like Asians, longer term, asset building for prosperity ... and the others who become disenfranchised. Including the middle classes who have many items on the agenda to spend on ... if only they had any money or ability to borrow left ... so no-one ends up wanting or being able to spend. Plunger [HYPER-deflationist]